What's Going on with Gold?

by Tomas SalamancaFor those of us who think that the world's central banks have been placing too much faith in the money printing press as a means of rousing sluggish economies, last week was bewildering. Gold closed the week below US$1500 per ounce. Not since June 2011 has the yellow metal traded beneath that level. Indeed, well before the breach of $1500, gold had been languishing after hitting an all-time high of $1900 in September 2011, stuck as it was within a range between $1800 and $1520.

All this was despite the Fed's adoption of QE3 during that period along with the ECB's declaration to do whatever it takes (i.e., print oodles of euros) to save that 17 nation currency. Not only that, the loss of depositor funds held in Cyprus' banks exposed the vulnerabilities of the prevailing financial order. †With all the fiat money being churned out by governments, and with the safety of that money coming under serious question, why is gold falling instead of shooting up?

One possibility is that the Austrian critique of monetary policy post-financial crisis was wrongheaded and that the dominant Keynesian monetarist school of thought was on the right track all along. According to the latter view, the damage wrought on the economy by the financial tempests of 2007-2009 could only be cured by an extraordinary campaign of monetary stimulus to prevent a deflationary spiral from overtaking the economy into a repeat of the 1930's. As for the inflationary threat posed by such stimulus, Keynesian monetarists discount it on the argument there is a great deal of slack in the labor market in periods of economic stress. As such, wage pressures will not cause the prices of goods and services to rise.

All of these ideas have been slammed by heterodox types like Austrian economists, who have warned of hyperinflation, and gold going to $10,000.

So the collapse in gold is not about gold, but about vindication for a large corpus of belief and economic research, which has largely panned out. Itís great that our economic elites know what theyíre talking about, and have the tools at their disposal to address crises without creating some new catastrophe.

Things arenít great in the economy, but the collapse/hyperinflation fears havenít panned out, and the decline in gold is a manifestation of that.

First of all, I am not aware of any consensus among Austrian economists that gold is going to $10,000 per ounce. To the extent there is any agreement at all, it is that gold is a solid investment going forward so long as central banks remain committed to inflationist economics, though how high it goes eventually few pretend to know. Austrian economists, at least if they are adhering to Ludwig von Mises, tend to be quite adamant on the point that exact price forecasting is a mug's game.

Secondly, the gold market, just like any market, is driven less by assessments of the past than it is by expectations of the future. So inasmuch as the price trend has been downward of late, this only indicates that market participants have revised their estimates of how monetary policy might cheapen the US dollar going forward. By taking into account indications of strength in the US economy, in addition to various intimations by the Fed about the approaching end days of quantitative easing, gold traders are factoring in the potential of somewhat tighter money ahead. It does not mean that the enormous monetary stimulus already undertaken has not depreciated the value of the US dollar. Let's not forget that gold remains at more than double the level it was amid the throes of the financial crisis in the fall of 2008 just before the Fed's quantitative easing efforts began. Underlining the primacy of expectations in explaining market movements is that gold has persisted upward in Japanese yen terms (going above the 140,000 per ounce level) where the recently elected Shinzo Abe government has made crystal clear its intention of pumping up the money supply to revive that country's economy.

Lastly, financial markets should not be automatically assumed to be rational at any given point in time. The idea that markets are rational, that all available information is assimilated into current prices, assumes that equilibrium is a normal state of affairs. Unlike orthodox neo-classical economists, Austrians do not accept that supposition. For Austrians, markets are merely tending towards equilibrium, rather than being in equilibrium. In other words, there is almost always going to be information that is not reflected in current prices. A big part of what entrepreneurs do in the economy is to uncover and exploit such information to generate profits.

And this leaves open the possibility that the gold traders which happen to be moving the market right now are not adequately factoring in the implications of what our central banks are doing to our money.
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Tomas Salamanca is a Canadian Scholar.

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